Sources of the US budget deficit – with data!

It is easy to be jaded about the news about the financial situation in the US government, especially when it seems that two sides are continuously arguing over which group will receive money and subsidies and which group will not. It is also easy to become cynical about the process because it does involve no small amount of corruption and waste. Political candidates loudly tout the problems with jingoistic one-liners during their campaigns but they always seem to fail to solve the problems that they once highlighted. This article is the first in a series of pieces that will focus on the US federal budget, beginning with a look at the history of the federal debt. Later, we will relate the federal budget to the rest of the economy and finally explore options for solving budgetary issues and repairing the economy.

In order to find a solution to the current financial situation, it is necessary to understand the actual problem. It is insane for one to expect to solve a problem with incorrect information. Therefore we need to end some myths regarding the budget.

Fig. 1: US Federal Debt as a Percentage of GDP, 1800-1999 (Wikipedia)

First, there were never any ‘good old days’. In Figure 1 you can see that the United States federal government has been in debt during its entire existence. The magnitude of the debt in uncorrected dollars can be found at the website of the U.S. Treasury, where you can see that the U.S. debt was $75,463,476.52 in the year 1791. As it turns out (and as we will see over and over again), war is expensive and the American Revolution that ended in 1783 had cost $37 million at the federal level in addition to $114 million in expenditures by the states, funded by loans from France and the Netherlands and the issuance of paper money (Jensen, 2004). The population of the US by 1790 was about 3.9 million, so the debt corresponded to roughly $38 per person in 1790s dollars (the equivalent of $920 per person in equivalent purchasing power in 2010). So the picture has never been quite so pretty as the image that is so often laid out for us when we are told of the halcyon past in which hard work and a dollar meant something because the dollar once had more value than it does now. According to the U.S. Treasury, the closest that the nation ever was to being debt free was during the years 1835 and 1836, when the debt was between $30,000 and $40,000.

Also, as population increases, government gets bigger. People ridicule “big government” but the government for a nation of 300 million people should be expected to be large. It should not be a surprise that the annual budget is given in trillions of dollars because each of the 300 million people contributes an average of at least a few thousand dollars to the budget per year. It is simple math. And what do we get for that? National Parks, Environmental Cleanup, some health care and Social Security (not as much as other countries), unemployment benefits, research and development, and (increasingly) the military and its associated wars. The government can help to improve the lives of all people if our tax money is invested properly. But therein lies the rub: We have a responsibility to hold our leaders’ feet to the fire to ensure that they do invest our money properly! Remember, Benjamin Franklin warned us in saying that we have “A Republic, if you can keep it.”

Fig 2: US Federal Deficits over Receipts, 1901-2000 (Wikipedia)

Another myth is that there is a problem with “tax and spend liberals.” Here you can see the annual deficits or surpluses as a fraction of incoming revenue during the 20th Century. The most obvious deficits occur at the end of the 1910s (World War I), during the 1930s (The Great Depression) and during the early 1940s (World War II). You can see that war and the inevitable collapse of laissez faire capitalism are very expensive. The Great Recession dip is not shown here because it took place in 2008. In addition, there are continuous deficits between the late 1960s and the mid-1990s. This is largely due to the impact of the Korean War, the War in Vietnam, the military buildup during the 1980s and the Gulf War in the early 1990s. That’s right, the problem with the U.S. budget is with war and the national security state, not “tax and spend liberals.” This is made abundantly clear in Figure 3, where excepting World War II (Roosevelt) and the first year of the Obama Administration, when it inherited structural deficits from the Bush Administration, the Democrats have actually done a better job at reducing the deficit than any of the Republicans since Nixon.

Fig. 3: US Gross Debt as a Percentage of GDP by American President, 1940-2010 (Wikipedia)

Fig. 4: US Gross and Public Debt since 1940 (Wikipedia)

You can see that I have shown you the debt as a fraction of GDP in Figures 1 and 3. That is because while the total amount of money that the US owes its benefactors has gone up nearly monotonically since 1945, the debt does become less expensive as the economy grows. In fact, economic growth can be used to pay off the debt provided that the interest payments are not too large. The top panel of Figure 4 shows the difference between the US gross debt (annual revenue – spending) and the public debt (the gross debt, adjusted for in-(de-)flation and GDP growth). Notice the downward trend in both lines during the late 1990s. That was due to Clinton, a democrat.

So here you go:
1. The federal deficit is primarily due to spending on wars and the national security state.

2. The Democrats have reduced the federal debt while the Republicans have expanded it.

3. The US has ALWAYS been in debt!

4. (Very important) But the debt gets cheaper, provided that the country can sustain economic growth. (This requires that money is spent on things that promote economic growth – we’ll discuss this in another article.)

Recall that President Clinton actually reduced the size of the US debt. The size of the US debt in 2000 was $5.6 trillion. The federal debt in the spring of 2011 is expected to rise to about $14.3 trillion. What happened?

Fig. 5: Makeup of the US Budget Deficit from 2009 (Center on Budget and Policy Priorities)

Figure 5 shows the problems in this plot of the size of the current annual budget deficit, broken down year by year. The original data is from the Congressional Budget Office. As you can see, most of the problems arose from the Bush Administration. The wars in Iraq and Afghanistan have been long and very expensive (to the tune of about $200 billion per year). There was an uproar in what seemed to be the sudden expansion of the annual budget deficit when President Obama placed them on the federal budget for the first time. President Bush had always kept them off the records using emergency funding legislation. That is: he cooked the books by not counting money that we were spending. Next, the tax cuts that went almost entirely to the wealthiest 5% of Americans account for 25% of the budget deficit and that fraction, due to various formulae and mandates, is set to increase with time. The Bush-era TARP (the Wall Street bailout) accounts for another third. And the remainder is a loss of revenue due to fewer people paying taxes (as many are unemployed during the recession) and the relatively small stimulus package that was put in place during Obama’s first year.

So the lion’s share of the current budget deficits are due to the Bush Administration’s running headlong into two wars, the lack of regulation that led to the financial crash in 2008, and the subsequent bailouts. That is where we are now – and the situation has not improved much because Congress extended the Bush tax cuts for another two years at the end of 2010, we are still involved in multiple wars, and Congress has not yet passed stringent re-regulation of the financial markets. Luckily, the federal debt has been higher as a fraction of GDP in the past (although American manufacturing was higher then) and we can afford the debt for now. But it is a large debt and we will discuss what can, should and likely will be done about it in the next post that we have on the subject in a couple of days. Stay tuned!

References
Jensen, Merrill. The Founding of a Nation: A History of the American Revolution 1763–1776. (2004)

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